A Beginner's Guide to Cryptocurrency Tax
How is crypto taxed and do you pay taxes on Bitcoin?
Yes, you absolutely do pay taxes on Bitcoin and other digital assets. For federal income tax purposes, the IRS treats crypto as a capital asset, not currency. This means that when you sell, trade, or use it, you might have a capital gain or loss, similar to trading stocks.
What are digital assets?
The US Internal Revenue Service (IRS) defines digital assets as 'digital representations of value on a cryptographically secured ledger or similar technology.' For federal income tax purposes, any asset with these characteristics is treated as a digital asset. Examples include:
- Convertible virtual currency and cryptocurrency
- Stablecoins
- Non-Fungible Tokens (NFTs)
Crypto tax rates
Tax rates depend on your income bracket and the nature of your crypto transactions. For instance, long term capital gain, resulting from holding a digital asset for more than a year, is taxed differently than short term capital gain. Your holding period begins the day after it is received. Your tax bracket will determine your rates, so it's best to consult the current Federal Income Tax Brackets and Crypto tax rates for specifics.
Buying or selling cryptocurrency as an investment
Any sale or trade of cryptocurrency that results in a capital gain or loss is a taxable event. If you sell your crypto for more than your cost basis (essentially what you paid for it), then you owe crypto taxes on that gain (in the form of either capital gains tax or ordinary income tax).
Money lost on crypto and its income tax implications
If you sell your cryptocurrency at a loss, that loss can be offset against capital gains, reducing your tax burden. These are termed as capital losses and are integral to tax strategies like tax loss harvesting.
Do you pay capital gains on crypto?
Indeed. When you sell a cryptocurrency for more than you purchased it, the profit is considered a capital gain, and you are expected to pay capital gains taxes. In other words, your gain or loss will be the difference between your "basis" in the virtual currency and the amount you received in exchange for the virtual currency.
How do I determine my basis in virtual currency?
Your basis (aka “cost basis”) is the amount spent to acquire the virtual currency, including fees, commissions and other acquisition costs. This can be increased by certain expenditures and decreased by certain deductions or credits. This adjusted amount is called adjusted basis.
Do I recognize a gain or loss if I sell property for cryptocurrency?
Yes. If you sell property held as a capital asset in exchange for cryptocurrency, you will recognize capital gains or losses. Property sold - that is not a capital asset - in exchange for cryptocurrency, will be recognized an ordinary gain or loss. Such gains and losses are taxable events.
If you receive cryptocurrency as payment
Such crypto transactions are treated as taxable income, based on the fair market value of the crypto on the day you received it.
Taxes on crypto payments, staking, and mining
Accepting crypto as payment for goods or services renders that amount as taxable income. Moreover, mining or staking digital assets, such as Bitcoin, brings them under the umbrella of ordinary income, which might be subject to self-employment taxes.
Do I have income if someone pays me with cryptocurrency for my service?
Yes. When you get virtual or digital currency in return for services you provide, whether as an employee or not, this is considered taxable ordinary income.
In addition, the fair market value of virtual currencies paid as wages is subject to federal income tax withholding, and employment taxes. The fair market value of virtual currencies you receive for services as an independent contractor is considered self-employment income and is subject to self-employment tax.
Do I have income if I pay someone with cryptocurrency for services received?
Yes. Paying for services with cryptocurrency held as a capital asset is considered an exchange, resulting in a capital gain or loss. The gain or loss is the difference between the service's fair market value and your adjusted basis in the exchanged cryptocurrency.
Do I have taxable income if I received new cryptocurrency after a hard fork and airdrop?
Yes. If you acquire new cryptocurrency from a hard fork - an event where a single cryptocurrency splits into two due to changes in the protocol - and then receive additional units through an airdrop, where new coins are distributed to existing holders, you must report taxable income in the year you receive the cryptocurrency. This income is considered ordinary income and equals the fair market value of the new cryptocurrency at the time it is recorded on the distributed ledger, provided you have the ability to sell it.
Do I have taxable income when my cryptocurrency goes through a soft fork?
No. A soft fork - which is a change in distributed ledger's protocol that does not split the ledger - does not create a new cryptocurrency. Because you do not receive new cryptocurrency from a soft fork, the soft fork will not result in any income to you.
If I donate cryptocurrency to a charity, do I have to recognize income?
No. Donations of crypto assets to a charitable organization described in section 170(c) of the US Internal Revenue Code (IRC), will not result in the recognition of crypto income, gain, or loss from the donation. Instead, you can claim a charitable contribution deduction.
Cryptocurrency received as a gift?
No. If you receive virtual currency as a bona fide gift, you do not have taxable income until you sell, exchange, or otherwise dispose of it. Your basis for calculating gain is the donor's basis plus any gift tax paid. For loss, it's calculated using the lower of (1) the donor’s basis or (2) the fair market value of the virtual currency at the time you received the gift.
Your holding period for the cryptocurrency includes the donor’s holding period, but if undocumented, it starts the day after you receive the gift.
Keep records and fill out tax forms
Maintain detailed records of your crypto transactions to determine if you owe income taxes at the end of the tax year. You must keep records that document: (1) your purchase, receipt, sale, exchange or any other disposition of the crypto assets; and (2) the fair market value of all crypto assets received as income or as a payment in the ordinary course of a trade or business.
What happens if you don't report cryptocurrency on taxes?
The IRS has mechanisms to track certain crypto activity. Failing to report can result in penalties or audits.
Are there tax-free crypto transactions?
Certain crypto gifts and donations might be tax-free, but they often have associated gift tax implications. Consult with a tax professional for guidance.
Other crypto tax considerations
From crypto airdrops or hard forks to staking, mining, and exchanging one cryptocurrency for another, all these can be taxable events. It's crucial to understand the tax implications of each to ensure you're compliant and not caught off-guard.
Conclusion
Navigating the intricacies of cryptocurrency tax can be challenging. From understanding capital gains to keeping immaculate records, being proactive will make tax season more manageable. Always consider seeking tax advice if unsure about the nuances of crypto taxes to avoid any potential pitfalls.